Why US Q1 GDP’s Potential Negative Flip Is Positive

After the Census Bureau released March trade numbers, headlines highlighted the US' trade deficit, which surged to its highest level since 2008. Since Q1's preliminary GDP estimate used a wild guesstimate for March trade, this news triggered fears Q1 GDP growth will be revised to a contraction. And hey, maybe! But a closer look at March trade gores those economic slowdown fears-and serves as an apt reminder to not rely on GDP (or any one measurement) as the definitive gauge of the economy's health.

The trade deficit soared because imports rose 7.7% m/m, while exports rose just 0.9% m/m. Judging by recent trends, this is near-entirely due to the resolution of the West Coast Ports labor dispute. Excluding Energy products (to remove oil prices' skew), imports grew 0.7% m/m, on average, in 2014.^[i] But in January, container ship unloading slowed as the longshoremen's dispute with shipping companies escalated, and imports fell -1.5%. In February, when intermittent work stoppages began, imports fell another -4.0%. In March, when everything was finally hunky dory, dockworkers started unloading a backlog of container ships anchored along the west coast, and imports jumped. Now for any dataset, we caution against reading too much into any single month, but here is some striking evidence the big wobbles stemmed from the West Coast Ports labor dispute. Total goods imported through 26 West Coast ports jumped from $24.9 billion in February to $38.1 billion in March.^[ii] That difference accounts for more than 75% of total imports' $17.1 billion March rise. Despite the grand GDP conclusions of some, this report says little about the economy, and much more about work stoppages' temporary impacts and math.

Pundits have long focused on the alleged big negatives trade deficits present-a misguided take, in our view.^[iii] In GDP math, exports are counted as positive while imports are subtracted. The result-net trade-is then applied to headline GDP. This is all well and good for arbitrary calculations, but it also misconstrues what imports represent. High imports suggest domestic demand is healthy and consumers are, well, consuming. US firms selling imported goods benefit. Heck, some US imports are components, later assembled, sold and shipped out as US exports. The trade balance doesn't take that into account and presents a simplified, black-and-white picture. A country could export a ton of goods and services and still run a deficit if it imports more. Even though the US has run a trade deficit for 40 years, it has remained one of the world's strongest economies. Interestingly, during recessions, the trade deficit often shrinks-domestic demand weakens, so we import less. But few would argue what we need is a good, big, fat recession to cure our nasty trade deficit. In our view, a country's total trade (exports plus imports) is a more meaningful measure. With exports and imports both up in March, demand seems healthy here and abroad.

Even so, intrepid economists, armed with these March trade data, are doing some classic economist, all-else-equal, straight-line math to the preliminary Q1 GDP estimate-projecting the second reading to show contraction anywhere from -0.2% seasonally adjusted annual rate (SAAR) to -0.5%. Yet this seems a tad premature. Other data get updated, too! An upward revision to business investment or personal spending could cancel out imports' rise. The BEA has also been investigating why Q1 GDP numbers still seem to be chilled by the winter despite seasonal adjustments-this could lead to a significant revision.

More importantly, even if the quarter gets revised from growth to contraction, it doesn't mean the economic expansion is imperiled. Q1 2011 GDP was revised from growth of 1.8% SAAR to 0.4%, then to 0.1%, then to a contraction of -1.3%-all between mid-2011 and 2013. The most current revision says Q1 2011 GDP shrank by -1.5%-who knows how this figure will change in July 2015? We saw a similar pattern last year, too. Q1 2014 GDP growth was first estimated at a scant 0.1% SAAR. The first revision dropped it to -1.0%, the second to -2.9%, and a third revision bumped it back to -2.1%. GDP is constantly revised both higher and lower, sometimes years after the fact. But the occasional contraction-or even muted quarter of growth-hasn't halted the US economy's expansion. Moreover, stocks are forward-looking. They don't really care what statisticians eventually figure out the US economy did in Q1-they've already moved on. They're looking to the future, not the past.

And looking ahead, it's quite likely weaker Q1 GDP, whatever the final tally, proves to be a one-off blip. The chilly winter is gone, ports are back to normal, and The Conference Board's Leading Economic Index (LEI) is enjoying a 14-month hot streak. All suggest this expansion is alive and kicking.

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[i] Source: The US Census Bureau, as of 5/8/2015. "US Trade in Petroleum and Non-Petroleum Products by End-Use." Average of month-over-month percentage change from January 2014 - December 2014.

[ii] Source: USA Trade Online (via the Census Bureau's "Graph of the Month.").

[iii] We think that's mostly because "deficit" sounds bad while "surplus" sounds good.